On 12 July 2007, family-owned Huntsman agreed to be acquired by Hexion. Over a year later, things are not going quite as planned. Darrell Delamaide analyses what went wrong

September started off badly for the Huntsman family. Utah Governor Jon Huntsman Jr, a loyal supporter of Senator John McCain's presidential bid even against fellow Mormon Mitt Romney, got bumped from his prime time speaking slot at the Republican convention on 3 September when Hurricane Gustav forced the party to compress the schedule into three days instead of four, though he did get a chance to formally nominated Alaska Governor Sarah Palin for vice president.

On 8 September the family company, a maker of specialty chemicals, faced a lawsuit in Delaware court from its erstwhile suitor, Leon Black's Apollo Management, a private equity firm that a year ago agreed to acquire Huntsman Corp for $28 a share. Apollo's Hexion Specialty Chemicals was trying to back out of the merger, claiming that it no longer made sense under today's radically changed circumstances and that in fact the merged company would be insolvent the moment it came into existence.

What a difference a year makes. The twin torpedoes of skyrocketing oil prices and a worldwide credit crunch set off by the subprime mortgage debacle in the US blew up a merger that seemed like the culmination of shrewd deals by family patriarch John Huntsman Sr, who grew a small packing company into a chemicals company with $10 billion in annual sales.

Huntsman has countersued Apollo/Hexion, seeking damages of $3 billion or more if the private equity group fails to honour its commitment. Particularly galling for the Huntsman family is that they walked away from a strategic offer by Dutch chemicals maker Basell Holdings for the higher bid from Black's group, even though Basell had guaranteed a continued role for the top Huntsman management.

What appeared a year ago as a poster child for 21st century capitalism now looks like a cautionary tale about what can happen when a wheeler-dealer world buoyed by cheap and plentiful credit crashes into the hard reality of an economic downturn.

"A strategic acquisition partner is a lot safer for a company like Huntsman, or any family-owned company," says Roger Shamel, president of Consulting Resources Corp. "It's more durable and has a better chance of working out."

In retrospect, says this industry analyst, Huntsman might have been better off taking the Basell Holdings offer after all. "I've become a firm believer in the long term," says Shamel. "Wall Street and private equity firms are trying to operate in the short term – it's too much smoke and mirrors."

The legal fight between Huntsman and Apollo is being closely followed in US financial markets as it promises to establish some judicial precedents as to how free buyout firms are to be fair-weather friends. If Apollo wins and walks away scot-free from the merger, commentators say future acquisition targets will have to look hard at the premiums promised by private equity firms to win the deal.

In the Huntsman transaction, for instance, Apollo bid $28 a share, valuing the transaction at $6.5 billion and topping Basell's bid of $25.25 a share, worth $5.6 billion. (The transaction also included assumption of $4 billion in debt.)

The Huntsmans went for the higher bid, arguing it was a better deal for shareholders. But now Apollo claims it will not be able to get the financing it counted on for the deal. Banks will not be able to make loans for the deal because the resulting merged company would be insolvent. Apollo has a study from Duff & Phelps, a financial advisory firm that is a leading provider of business valuations, to back up its claims.

In August, some of Huntsman's hedge fund shareholders – DE Shaw, Citadel, MatlinPatterson, and Pentwater – offered to help out with the financing with a $500 million facility that would have to be paid back only if the merged company attained certain profit thresholds. If those thresholds are not reached, Apollo would owe nothing and would have shaved off $500 million from the purchase price.

But Apollo rejected the hedge fund offer out of hand. "While we appreciate the efforts of these shareholders, due to the dramatic increase in Huntsman's net debt and decrease in its earnings since last July, their proposal does not come close to making the combined company solvent," Apollo said in a statement.

Apollo is claiming that there has been a material adverse event at Huntsman as mounting debt and declining earnings no longer make it viable to merge with Hexion and take on the debt envisaged in the merger accord, so that Hexion doesn't even owe Huntsman the termination fee of $325 million.

Peter Huntsman, CEO of the family firm, rejects the claim, saying that earnings in the past 12 months are off only 6% from earnings in the 12 months leading up to the merger.

Huntsman stock plunged when Apollo pulled the plug on the deal in June, dropping from above $20 a share to a 52-week low of $9.76 on 28 June. By the time the trial was ready to start on 8 September, the stock had only recovered to the $12-13 range – a far cry from the $28 a share in the merger agreement. Huntsman said its overall claim for damages could be $4.5 billion because of the harm done to shareholders by the sharp fall in the stock price.

The outlook for Huntsman if Apollo wins is uncertain. "The fact that the company was willing to sell itself in the first place was somewhat telling," says industry analyst Shamel. "It's tough to go back and be a strong stand-alone company. It makes them more a candidate for someone else to look at."

Apollo has problems of its own. The private equity firm plans to list its shares on the New York Stock Exchange and doesn't need major litigation hanging over it. Also, Hexion, which Apollo cobbled together from the old Borden chemical company and other acquisitions, is one of the leading producers of bizphenol A, the plasticizer that has come under fire this year for possibly interfering with human hormones.

As far as the Huntsmans are concerned, however, a deal is a deal. "If this [lawsuit] prevails," Huntsman told the Houston Chronicle, "there's not a merger agreement in America that will be worth the paper it's written on."